Should you make additional mortgage prepayments?

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Before making extra payments on your loan many financial advisors suggest having a 3-6 month nest egg. This will give you peace of mind knowing that if something catastrophic happens, such as losing your job, you will be prepared. Also, before prepaying your mortgage, how is your credit card situation? If you have $5000-10,000 in credit card debt and are paying 10-24% per year in interest, you should pay off the credit cards first. Once you’ve paid off the credit cards, then weigh the pros and cons of prepaying the mortgage. Many financial advisors suggest that there are better investment avenues than paying off a mortgage. On the other hand, some people would prefer the peace of mind knowing that they will own their home free and clear when they retire. If that is the road you decide to take, there are a few things you should consider.

  1. Is your loan subject to a prepayment penalty? If so, is it a one-time fee and how much is it? Some lenders state there is no prepayment penalty and others will charge a fee if more than 10% is paid in any one year for a specified time period.
  2. Determine the monthly amount you can afford to pay and stay consistent, don’t skip payments
  3. When writing the check to your lender, make a note on the check stating that the additional amount goes towards the principal. Most lenders provide a separate space for each payment in which you can specify an extra payment. Don’t just trust the lender, you should also keep track of the extra payments, the date, the check number and the amount applied. You might even write a separate check for the principal payment.

If you plan on moving in a few years it’s really not beneficial to prepay. If you have found your dream home and plan on retiring, you might consider it. Prepaying your mortgage can literally save you thousands and reduce years off your mortgage. Just paying one extra payment each year could knock a 30 year mortgage down to 22 years and a few months.

What about a biweekly program? Biweekly programs are setup so that you make half a payment every 2 weeks. At the end of the year you have accumulated an extra month’s payment that will be applied to the principal balance. There are companies who can setup this payment program, but it would be easier and cheaper to just make additional monthly payments. It is cheaper because a biweekly payment program usually charges a fee for the electronic withdrawal and a startup fee between $49-$500 dollars to set you up on their program.

Drawbacks: This type of program uses an automatic electronic withdrawal which is done every two weeks from a checking or savings account. If you need to halt the withdrawal you need to submit a written request to do so. Biweekly programs also charge a monthly fee from $3-$8 each two week period and this fee is not applied to your principal reduction. So you’ll end up paying $79-$208 every year to be on the biweekly program. This is money you could use to reduce your principal balance.

Advantage: For some people managing their money is a difficult task and this program might work well for them. Once they are set up, everything is taken care of for them.